THE ROLE OF ANTITRUST IN PROTECTING COMPETITION, INNOVATION AND CONSUMERS AS THE DIGITAL REVOLUTION MATURES: THE CASE AGAINST THE UNIVERSAL‐EMI MERGER AND E‐BOOK PRICE FIXING Mark Cooper, Director of Research, Consumer Federation of America Fellow, Donald McGannon Communications Research Center, Fordham University Jodie Griffin, Staff Attorney, Public Knowledge June 2012 ABSTRACT This paper presents a detailed analysis of the proposed merger between Universal Music Group (UMG) and EMI by applying the standards and methods outlined in the recently revised Department of Justice/Federal Trade Commission Merger Guidelines. It shows that the UMG‐EMI merger is “an unfair method of competition” that constitutes “an unreasonable restraint of trade” because it will “substantially lessen competition” and is “likely to enhance market power.” Simply put, the post‐ merger firm will have a strong incentive and increased ability to exercise market power, particularly in undermining, delaying, or distorting new digital distribution business models, in a market that has been a tight oligopoly for over a decade. The merger creates a highly concentrated market by eliminating one of only four major record labels and results in an increase in concentration that is five times the level that the DOJ/FTC identify as a cause of concern. The recent history of anticompetitive, anti‐consumer conduct by this tight oligopoly and the role of EMI as a maverick in the digital era compound the anticompetitive effects of the merger and significantly increase the likelihood that the merger will not only result in higher prices but also undermine incipient competition. Claims that piracy will prevent the abuse of market power are directly refuted by evidence on consumer purchasing behavior, estimates of elasticities of demand by academics, and marketing research conducted by the music industry. The analysis demonstrates that the industry has chronically and grossly overestimated the role of copyright infringement in the development of digital distribution. Correcting this misrepresentation of the extent of infringement is necessary to ensure that policymakers have a proper understanding of the full benefits of digital technologies. The strong parallels between the impact of the merger on the development of digital disintermediation in the music sector and the recent case brought by the Department of Justice against e‐book publishers highlight the economic efficiency and consumer benefit from the digital distribution of goods and services. The anticompetitive tactics of the dominant, incumbent, physical space firms remind us that these firms will stop at nothing to delay change and preserve their dominance. Antitrust authorities and others must use the full range of tools available to protect competition, innovation, and consumers and ensure that consumers and the economy enjoy the full benefits of the development of digital technologies. TABLE OF CONTENTS I. INTRODUCTION 1 A. Purpose 1. Traditional Horizontal Merger Concerns 2. A Key Moment in the Development of Digital Distribution B. Outline II. THE ROLE OF MERGER REVIEW IN THE ENFORCEMENT OF THE ANTITRUST LAWS 4 A. Governing Principles B. The Merger Guidelines 1. Key Thresholds 2. The Impact of the Merger on Concentration III. THE UMG‐EMI MERGER RAISES SIGNIFICANT COMPETITIVE CONCERNS 8 A. Market Structure 1. Horizontal Concentration 2. History B. Conduct: 1. Product Offerings: The Elimination of Singles 2. Pricing Patterns: Illegally Fixing the Price of CDs 3. Margins IV. PIRACY V. EFFICIENCY AS EXPLANATIONS FOR THE TRANSFORMATION OF THE MUSIC MARKET 19 A. The Claim That Piracy Can Discipline Market Power Does Not Ring True B. The Original Claims of Piracy were Vastly Overstated C. An Unsustainable, Anticompetitive, Anti‐Consumer Business Model D. The Bottom Line on Piracy and the Real Lessons of Technological Change that the Industry Resisted So Strenuously V. THE IMPORTANCE OF INCIPIENT COMPETITION, COORDINATION, MAVERICKS, 30 AND MONOPSONY A. The Incipiency Standard B. The Continuing Vulnerability of Non‐Majors 1. Independent Labels 2. Unsigned Artists 3. Monopsony C. The Role of Mavericks D. Contemporary Pricing VI. LESSONS FROM THE DOJ E‐BOOK PRICE FIXING CASE 42 A. The Challenge of and Response to New Distribution in Publishing and Music B. Efficiency 1. Consumer Cost Savings 2. Author Benefits C. Predatory Pricing D. Conclusion: The Importance of Digital Disintermediation and the Role of Antitrust BIBLIOGRAPHY 53 APPENDIX: THE WELFARE ECONOMICS OF DIGITAL DISINTERMEDIATION 58 LIST OF EXHIBITS II‐1: DESCRIBING MARKET STRUCTURES 6 II‐2: CONCENTRATION THRESHOLDS AND IMPLICATIONS OF MERGER‐ 7 RELATED INCREASES IN HHI III‐1: IMPACT OF THE UMG‐EMI MERGER ON MARKET CONCENTRATION 8 III‐2: STABLE LEADING FIRMS IN THE U.S. MUSIC INDUSTRY 10 III‐3: THE REPEATED CASCADE OF MUSIC MEDIA 11 III‐4: MEASURES OF LONG‐TERM MARKET STRUCTURE 11 III‐5: U.S. SHIPMENTS OF ALBUMS AND SINGLES 13 III‐6: MARKET STRUCTURE AND CD PRICING 15 III‐7: WHO GETS WHAT FROM THE MUSIC CONSUMER DOLLAR 16 III‐8: REVENUE PER UNIT SHIPPED 17 IV‐1: PRICE POINTS FOR DIFFERENT ALBUM TECHNOLOGIES 20 IV‐2: THE SMALL IMPACT OF PIRACY ON MUSIC SPENDING: TIME SPENT 21 LISTENING V. MUSIC SPEND IV‐3: ALTERNATIVE VIEWS OF THE EXTENT OF PIRACY 22 IV‐4: MEASURES OF THE QUALITY OF NEW RELEASES 23 IV‐5: COMPONENTS OF STOCHASTIC TREND 26 IV‐6: FACTORS THAT AFFECT PIRACY V. PURCHASE 28 IV‐7: NEW ALBUM TITLES RELEASED (000) 29 V‐1: FOUR FIRM CONCENTRATION RATIO BY PRODUCT IN THE DIGITAL ERA 32 V‐2: INDEPENDENT LABEL SHARE OF TOP SELLING ALBUMS BEFORE AND 33 AFTER DIGITAL SALES V‐3: DIGITAL MUSIC SALES 35 V‐4: THE IMPACT OF DIGITAL ALBUM SALES ON PHYSICAL CD REVENUE 40 V‐5: THE RECORDING INDUSTRY PRICING STRATEGY IN THE DIGITAL ERA: RAISE SINGLE PRICES 41 MORE THAN ALBUMS TO INCREASE ALBUM SALES AND REVENUE PER UNIT SHIPPED VI‐1: PARALLEL PROBLEM, PARALLEL ILLEGAL CONDUCT 44 VI‐2: WHO GETS WHAT FROM BOOK PURCHASE PRICE? 47 VI‐3: BOOK PUBLISHING REVENUES 48 VI‐4: TITLES PUBLISHED PER YEAR (MILLION) 49 I. INTRODUCTION A. PURPOSE In a recent letter to the Federal Trade Commission (FTC) and the Congressional Committees with oversight over the antitrust laws, the Consumer Federation of America (CFA) and Public Knowledge (PK) called for close scrutiny of the proposed merger between Universal Music Group (UMG) and EMI. The letter pointed out that “the Department of Justice’s (DOJ) recent e‐book antitrust complaint immediately casts a spotlight on another action under review by the antitrust authorities that raises similar and parallel issues.” (Cooper and Griffin, 2012) Universal immediately objected to the parallel we drew between the DOJ case against e‐ book price collusion as well as our call for antitrust scrutiny of the proposed Universal‐EMI merger. CFA’s effort to compare this case to the government’s e‐book case completely misunderstands the law. The e‐book case is about an alleged illegal price‐fixing conspiracy. Market shares don’t matter in a case like that, it’s just as illegal for two tiny bookstores to fix prices, as it is for giant publishing companies… The law governing mergers is totally different, and most mergers, like this one, are ultimately found to be beneficial to competition and consumers. (Sisario, 2012) This paper shows that the Universal response could not be more wrong on both of the issues raised in its response. • The law governing merger review is exactly the same as the law governing collusion. • Under the antitrust laws the UMG‐EMI merger represents a business agreement that constitutes “an unreasonable restraint of trade” that will “substantially lessen competition” and constitutes an unfair method of competition, which is unlawful because it is “likely to enhance market power.” (DOJ/FTC, 2006) As we pointed out in our letter, this is a particularly important moment to reject gross misrepresentations of the antitrust laws, like the one offered by Universal and the book publishers. The Department of Justice action against price fixing by five major publishers underscores the ongoing effort of antitrust authorities to define the proper role for antitrust in the development of the digital economy. The economic efficiency and consumer benefit from the digital distribution of goods and services are transforming the way the market meets consumer demand. Incumbent physical space firms confronted with a more efficient business model will stop at nothing to preserve their dominance. The actions of antitrust authorities and others to ensure that incipient competition is not squelched by anticompetitive tactics should include the full range of antitrust powers that have traditionally been used to ensure that consumers and the economy enjoy the benefits of the greatest amount of competition possible (Cooper, 2001) – denial or conditioning of mergers and acquisitions that substantially lessen competition, reversing actions that defend or expand monopoly power by undermining competition, prevention of unilateral monopoly abuse, and blocking of collusion. 1. Traditional Horizontal Merger Concerns In seeking to block and unravel the price fixing scheme hatched by five publishers, the DOJ alleged that a cabal of companies with a total market share of less than 50% could undermine or distort the growth of nascent competition from new digital distribution models by refusing to make 1 their products available to alternative distribution models or by manipulating the terms, conditions, or price of access to their products. (DOJ, 2012) • If five companies with a market share of less than 50% pose a threat to nascent competition from digital distribution models, does one company with a market share above 40% (Nielsen/Soundscan, 2012) pose a similar threat? We believe the answer is an emphatic yes. • Viewed through the lens of traditional antitrust practice and the lens of nascent development of digital distribution models, the UMG‐EMI merger poses a significant threat to competition and demands close scrutiny and vigorous remedy by the Federal Trade Commission (FTC), the sister antitrust agency to the DOJ that is reviewing the transaction.